athenahealth's (ATHN) CEO Jonathan Bush on Q3 2016 Results - Earnings Call Transcript

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athenahealth, Inc. (NASDAQ:ATHN) Q3 2016 Earnings Conference Call October 21, 2016 8:00 AM ET

Executives

Dana Quattrochi - Executive Director, IR

Jonathan Bush - Chairman & CEO

Karl Stubelis - CFO

Analysts

Mohan Naidu - Oppenheimer

Jeff Garro - William Blair

Jamie Stockton - Wells Fargo

Michael Cherny - UBS

Robert Jones - Goldman Sachs

George Hill - Deutsche Bank

Donald Hooker - KeyBanc

Ross Muken - Evercore ISI

Sean Wieland - Piper Jaffray

Ricky Goldwasser - Morgan Stanley

Greg Bolan - Avondale Partners

David Ho - Barclays

Sean Dodge - Jefferies

Charles Rhyee - Cowen

Garen Sarafian - Citigroup

Operator

Welcome to the athenahealth Third Quarter Fiscal Year 2016 Earnings Conference Call. As a reminder, today's call is being recorded.

At this time, I would like to turn the call over to Dana Quattrochi, Executive Director of Investor Relations for athenahealth. Please go ahead, Ms. Quattrochi.

Dana Quattrochi

Good morning and thank you for joining us. With me on the call today is Jonathan Bush, our Chairman and CEO; and Karl Stubelis, our Chief Financial Officer. On today's call, Karl Stubelis will share brief highlights from the prepared remarks we published yesterday and then Jonathan Bush and Karl Stubelis will take questions.

We would like to remind everyone that certain statements made during this conference call are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities Exchange Act of 1934 as amended, including statements regarding management's expectations for future financial and operational performance and operating expenditures, expected growth, and business outlook, including fiscal year 2016 guidance; statements regarding the availability and benefits of and demand for our service offerings; statements regarding the potential expansion and value of our network and progress towards building the healthcare Internet; statements regarding our ability to improve client satisfaction and our net promoter score, statements regarding changes in our senior management, and statements regarding our goal of transitioning all customers to streamline by the end of 2016 or early 2017 and the impact on client satisfaction.

Forward-looking statements may be identified with words such as will, may, expect, plan, anticipate, upcoming, believe, estimate, or similar terminology, and the negative of these terms. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those contemplated in these forward-looking statements.

These risks and uncertainties include those under the heading Risk Factors in our most recent Annual Report on Form 10-K, and other periodic reports filed with the Securities and Exchange Commission, which are available on the Investor Section of our website at www.athenahealth.com, and on the SEC's website at www.sec.gov.

Forward-looking statements speak only as of the date hereof, and except as required by law, we undertake no obligation to update or revise these forward-looking statements.

Finally, please note that on today's call, we refer to certain non-GAAP financial measures in which we exclude certain non-cash or non-recurring items such as stock-based compensation from our GAAP financial results. We believe that, in order to properly understand our short-term and long-term financial trends, investors may wish to consider the impact of these items as a supplement to financial performance measures determined in accordance with GAAP.

Please refer to yesterday's press release announcing our third quarter fiscal year 2016 results available on our website www.athenahealth.com for a reconciliation of these non-GAAP performance measures to our GAAP financial results.

With that, I'll now turn the call over to Karl Stubelis.

Karl Stubelis

Thank you, Dana. Good morning, everyone, and welcome to our third quarter fiscal year 2016 earnings call. As you know, athenaNation continues to build the most connected network in healthcare. We're leveraging our network to reduce client work while improving the patient and provider experience. We are harnessing the power of our network enabled services to help our clients thrive in this constantly evolving healthcare industry and to prosper in alternative reimbursement policy. And finally we're using our network insights to advance healthcare delivery.

In addition to all of this, we know there is plenty of work still ahead. We understand the importance of closing out the year with marquee deal announcements, momentum within our emerging services, and continued success with the streamline rollout to name a few.

But 2016 has been a bit bumpy and even though the pace of progress can lag behind our aggressive expectations, we feel good about this year's accomplishments in the long-term.

I will now highlight some of what is driving and supporting our optimistic outlook for the future. Let's start with network growth. We ended the third quarter with over 85,000 providers and over 83 million unique patient records and over 140,000 endpoints that exchange information. In Q3 alone, we added 3,829 physicians and a record 5,092 providers to our network. And our network growth expands well beyond physicians and providers.

As we extend our network enabled services across the continuum of care, network growth will be defined not just by providers but also patients, covered loss, discharge bed days, and more. We look to start providing these additional network growth metrics in 2017.

Now for bookings. They are late this year. We're an aspirational company with aggressive goals and we believe that 30% year-over-year bookings growth was the right target for 2016. But our weeds and meanings are behind plan in the small group and group segments as the lack of sense of urgency in the market has elongated the sales cycle.

Despite this headwind our sales teams keep signing new clients and expanding our wallet share with existing clients. To put this in perspective, we are currently at 80% of our bookings goal as of Q3 year-to-date. Based on our performance to-date and our sales pipeline we expect to come in below our goal of 30%, despite this underperformance we still expect to close additional bookings in 2016 to continue to deliver strong revenue growth.

We look forward to providing our financial outlook for 2017 at our upcoming Investor Summit in December.

Our mission is to be healthcare providers' most trusted service, helping them do well by doing the right thing. Our ability to deliver client results is central to this mission. We measure our success in several ways such as increasing client collections, improving quality metrics, reimagining the patient and provider experience, and reducing our client administrative burdens.

We are focused on developing and delivering network enabled services that reduce cost, improve cash flow, and drive quality for both patients and providers. The launch of the athenaClinicals streamline is one of the several initiatives underway to reimagine the client experience and take on additional client work. As we rollout, I think the clinical streamline to both existing and new clients we continue to prove that providers on streamline are not only more efficient at documenting the patient visit in the exam room but spend less time documenting the patient visit after hours. This further differentiates us from traditional EHR software vendors and has the power of our network enabled services.

To-date over 50% of our athenaClinicals providers nearly 90% of our client accounts have adopted the streamline experience. Notably we completed the migration of our entire small group client base during the third quarter and remain on track to transition the remaining the athenaClinicals client base by the end of 2016 or by early 2017.

Another key initiative for this year is to strengthen and scale our population health services. The signing of Dignity Health and Providence Health & Services recently followed by Tandigm Health marked watershed events for athenahealth as a provider of population health services. These organizations recognize our analytics, quality and care management network enabled services can help them manage risk populations and succeed under new reimbursement models. We believe that we have demonstrated time and again that we can partner with clients and consistently beat the national average against both cost and quality measures.

This was proven once again by the recently released CMS data highlighting the performance of our population health clients in the 2015 Medicare Shared Savings Program also known as MSSP. Notably 73% of the athenahealth clients achieved shared savings compared to just 29% for all other MSSP ACOs in 2015.

athenahealth clients also earned 15% more in take home shared savings. In addition to our out performance against national averages we also beat our own industry-leading results for the 2014 MSSP program by helping our clients enjoy an on-average 22% increase in per member, per year shared savings in 2015 over 2014, but we are never satisfied. Developing a more direct connection with the patient is fundamental to our long-term success.

And the August 2016 acquisition of Patient IO is a key step in establishing a patient facing presence. Patient IOs mobile and web-based applications help providers turn care plans into simple, actionable daily tasks for patients, including managing medications, reviewing educational content, and recording self report the data.

The solution is designed to improve care plan adherence and reduce readmissions. This integrated functionality was already live in market with select clients prior to our acquisition and will be made available to new athenahealth population health clients as a need of component of the services in Q4 2016.

Let's now talk about network insights and performance. Over nearly 20 years we've built a nationally connected clinical network that has grown to over 85,000 providers and over 83 million patient records in the network today. This connected daily increasing network, combined with our massive dataset, gives us visibility into what is actually happening in healthcare.

We can learn from the network, identifying share best practices, and put our actionable insights to improve the way healthcare is delivered. During the third quarter, we officially launched athenaInsight, an online news hub reporting on U.S. healthcare by drawing upon the activity and trends from our network. For instance athenaInsight examined opioid prescribing trends on a national scale with reporting on the many dimensions of the Nation's opioid crisis through in depth features, expert interviews, and data backed charts and infographics.

The site also explores for example, the steps that medical practice can take to reach high performance and how our Texas community rallied to save its local hospital. We can also activate the latest and most evidence based clinical guidelines and deliver them rapidly to our clients. For example shortly after the Center for Disease Control and Prevention issued an emergency notification about the 14 confirmed cases of the Zika virus in Florida's Miami-Dade County, we assembled the task force to help affected clients. We used the power of our network to identify patients at risk and showed the clients how to activate the CDC's updated guideline to screen, educate, and protect their patients.

This is not the first time that athenahealth successfully responded to concerns about infectious disease. Recall last year at the height of the Ebola crisis in Texas, when we rapidly deployed an updated an CDC guideline with our athenaClinicals service to make the necessary content and was readily available to assess Ebola symptoms, travel history and risk exposure. Once again this illustrates the positive impact of how getting the right information at the right time and in the right place can have on patient care.

Now turning to our culture. We have always believed that accomplishing our vision and mission requires a culture of teachers and learners who tenaciously pursue team success; we believe our culture is key to delivering against our strategic initiatives and maintaining growth. As part of our 2017 strategic planning process, we spend a lot of time talking about our culture, however rewards and promotes our core values and how we can offer every Athenistas to a unique and rewarding experience.

We are thrilled to let you know that we have found our new Chief People Officer, who will be joining us in December 2016. We look forward to this new leader serving as our cultural champion and working in partnership with Jonathan Bush and other leaders in supporting the administrative operations of the business. We look forward to introducing this new leader to the investment community at our Investor Summit in December, stay tuned for more details.

With that, I will now begin the financial portion of today's call. Starting with the top-line, our third quarter revenue of $276.7 million grew 17% over the same period last year. This brings year-to-date revenue to $794.8 million or 19% growth over the same nine months period last year and in line with our fiscal year 2016 guidance.

However revenue performance is slightly behind plan year-to-date as strong performance in our core ambulatory business in the third quarter was partially offset by lower Epocrates revenues and slower than expected on-boarding of new clients into our hospital and population health services.

On a consolidated basis, our non-GAAP adjusted gross margin for the third quarter was 65% as compared to 62.9% in the third quarter last year. Our non-GAAP adjusted gross margin for the first nine months of 2016 was 63.3% was relatively in line with our internal plan. As planned in the third quarter, we continue to invest in both growth and innovation. Our GAAP selling and marketing investment of $59.1 million increased by $3.1 million or 6% over third quarter last year. While our GAAP research and development expense of $24.9 million increased by $2.3 million or 10% over third quarter last year.

We expect to continue to invest in growth and innovation as we look to fully unbreak healthcare as we expand our services across the full continuum of care. Our GAAP general and administrative expenses of $41.9 million increased by $7.1 million or 20% over third quarter last year. Our third quarter and year-to-date general and administrative spend was impacted by higher than expected legal expenses, facility related costs, and recruiting expenses. As a result of our higher general and administrative expenses incurred to-date, we expect our general and administrative costs as a percentage of revenue for full year 2016 to be relatively flat to last year.

Our non-GAAP adjusted operating income of $41.5 million for the third quarter grew 63% from $25.4 million in the third quarter last year, while our year-to-date non-GAAP adjusted operating income of $89.8 million grew 41% over the same nine month period last year. Notably, we have improved our non-GAAP adjusted operating margin by over 170 basis points from 9.6% in the first nine months of 2015 to 11.3% in the first nine months of this year. Our non-GAAP adjusted net income was $24.1 million for the third quarter or $0.60 per diluted share, up 68% from $14.3 million or $0.36 per diluted share in the same period in 2015.

Year-to-date our non-GAAP adjusted net income was $51 million or $1.27 per diluted share, up 42% from $35.8 million or $0.90 per diluted share in the same nine month period in 2015. These increases in non-GAAP operating income and non-GAAP adjusted net income are primarily attributable to our top-line growth.

As we set guidance once a year at our Annual Investor Summit throughout the year, we provide additional insights into our annual guidance given our visibility into performance. We are pleased to report that we are relatively in line with our internal financial goals for the first nine months of 2016.

Therefore, based on our year-to-date performance and our current expectations for the fourth quarter for 2016, we are providing additional insights into our fiscal year 2016 guidance as follows: We expect GAAP total revenue to be near the mid-point of the $1.85 billion to $1.115 billion guidance range. We expect non-GAAP adjusted gross margin to be near the mid-point of 63.5% to 64.5% guidance range. We expect non-GAAP adjusted operating income to be near the mid-point of the $120 million to $135 million guidance range and finally we expect non-GAAP adjusted net income per diluted share to be near the mid-point of $1.65 to $1.85 guidance range.

athenahealth is a transformational company committed to driving meaningful disruption to improve the healthcare industry. While we look to the long-term, we set annual goals toward building the healthcare Internet. Our success in the hospital and population health markets this year has affirmed our strategy and belief that we can become the healthcare Internet. But to no surprise, fast growth can produce growing pains. This does not discourage tenacious organization like us; it motivates us to make changes to our organization, our technology, our services, and even our culture.

Our mission would drive us in 2017 and beyond as we intensify our efforts to deliver true client success. We look forward to providing you with an update on our strategic priorities and financial outlook at our upcoming Investor Summit on December 15, 2016.

We appreciate you listening in and now look forward to your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions].

And our first question comes from Mohan Naidu of Oppenheimer. Your line is now open.

Mohan Naidu

Thanks for taking my questions. Jonathan, I want to look at the NPS score a little bit more there. I know you guys have been trying to address some of the client service issues but I want to focus on any product related issues that they are complaining about once they move into streamline and what is their reaction when they show, when you guys show them, the post migration productivity improvements that it brings?

Jonathan Bush

As I think, we've mentioned Mohan there is two phenomenon going on at the same time, one we thought when we rolled streamline out, there would be a real scale in customer service calls because our alpha test suggested so much greater productivity, so much less surface area of work for the customer to do. So we expected fewer calls. We hired in the customer support center accordingly, got a spike in calls as we force people through this migration and so you had a double whammy of a new user experience and long wait in the CSC. Those long waits in the CSC affected new customers and old ones alike. We fixed that, so this quarter we're now down about 100 and something seconds, I would like to have it under 60 seconds but it's under two minutes or about two minutes that where we think we're fine.

So we expect as the rest of the base moves over, the CSC, the net promoter score to go up but because of the double whammy it's sort of like don't tell me about how is a better application, I'm waiting on hold, I'm still mad. So this is the first quarter, we've had where we've got streamline stable and out to the majority of accounts about half the users, some of our biggest enterprise accounts wanted to go last to watch us get the kings out, good move on their part because they were kings and we got them out.

But right now, we think that we will start to see that uptick probably Q1 will be the first time where someone has actually had a couple of months of short customer service response time and high productivity on streamline.

Karl Stubelis

Yes, Mohan looking at the metrics that Jon was referencing here, we think that this is a leading edge, a lagging indicator excuse me. So the things that we care about and look at in our client service center or customer service center is the average second to answer and that is declining as Jon mentioned. Our service level that's where 80% of the calls are answered within 120 seconds, that's improving and the abandoned rate is actually going down and these are all year-over-year metrics that we're looking at.

So we feel like the investments that we've been making, listening to our clients and making things better, the recent belief of 1,610 are all positive steps to get there where we're just going to get this the ship turn around a little bit more and have the lagging indicators reflect where we think we're on the trajectory for right now.

Operator

Thank you. And our next question comes from Jeff Garro, William Blair. Your line is now open.

Jeff Garro

Yes, good morning guys. And thanks for taking the question. I wanted to ask about bookings a little bit more and revenue visibility, given these year-to-date bookings results and how the implementation pipeline looks currently, can you give us a preview ahead of the December Analyst Day on how revenue visibility and growth looks for 2017 and may be asked another way, what impact can rest of the year bookings have on 2017 growth versus 2018?

Jonathan Bush

I will start by saying no but may be Karl can do better.

Karl Stubelis

Yes, I was going to say well obviously we're in the Doubs of looking at the budget right now. It's shaping up nicely but in terms of giving guidance for 2017 that's a little bit premature. We've got great visibility; we've set guidance as it is related to 2016 nearly 11 months ago now back in last December, we're very, very pleased about. We got some good instrumentation and good visibility in the things but in terms of guiding or providing any insight into that, it would be premature for me to do.

Operator

Thank you. And our next question comes from Jamie Stockton of Wells Fargo. Your line is now open.

Jamie Stockton

Good morning. Thanks for taking my question. I guess --

Jonathan Bush

Louder and with feeling, Jamie.

Jamie Stockton

Excuse me.

Jonathan Bush

There you go, couldn't hear you in a sense.

Jamie Stockton

Oh, sorry. I will tell you let me pickup my headset.

Jonathan Bush

Oh god, much better.

Jamie Stockton

There we go.

Jonathan Bush

Guidance is improving by the minute.

Jamie Stockton

On the bookings front, it sounds like small and group is lagging, what you wanted to be on the other hand, you have hired a ton of reps recently and may be part of this is that you didn't have the staffing level that you wanted to have, I know you've alluded to that on calls earlier this year but part of me also wonders would you be hiring all of these new people if you didn't have leads for them to run down. So can you just talk to us about how should we interpret the significant hiring from a rep standpoint on the small and group front with the backdrop of bookings not exactly being what you want them to be year-to-date?

Karl Stubelis

Well obviously the first impulse we had, we had very high leads in the first quarter and we had been a little too conservative in our hiring. So we did a rush to catch-up. I do think now with another sort of 90 days of retrospect, Jamie, that there is another thing going on regarding the market. So we are really the government just two weeks ago chopped to the implications of the mix program by more than half, you cannot find the financial consequence of our quality scores whether two has come in two years. It's hard to figure out and it doesn't move the needle. That after chopping stage three of meaningful use, all of these things are resulting in a change in the dynamics from federally mandated revenues to organic costs.

So we are changing our shift from what is the government going to make you do next to what are the current cost of operating in your current environment. And that change in focus will help us with a change in kind of product market fit. We were incredibly successful at the product market fit mandate created by the government mandate. We had before the government mandate gain of eight years ago or last the eight year has been incredibly successful at the commercial payer and cost of billing gains. We are now kind of needing to tune our focus of the value prop around kind of the operational cost of managing quality in medical record information. We're getting a much tighter bead on how many FTEs each doctor employs, how many FTEs that the Internet takes out, that wasn't the focus, when you had to make a decision to get on to a medical record that could meet the quality reporting standards that were coming down on you, it is now rising, so that's new information for you Jamie and everyone listening.

We're very comfortable that we can return to a really extraordinary product market fit but I think the focus of the last six years really is coming to a close, is weighting more so than I thought when I last spoke to you.

Operator

Thank you. And our next question comes from Michael Cherny of UBS. Your line is now open.

Michael Cherny

Good morning guys and thank you for taking the question. So I hate to harp on the bookings number but I'm going to ask you the kind of a different way without in anyway trying to get you give guidance for next year. Over the last few -- I'm trying here, over the last few years particularly as you've seen some shifts with some of the larger enterprise contracts coming into play, the success you've had with companies like Ascension which I think outperformed your initial expectations by a pretty large factor. Have you seen any difference in terms of the conversion of bookings i.e. when you do well in bookings, I look back last night lot of the performance you've had on the financial scorecard, does the timing of the performance on the financial scorecard is what we have to go on. Had that changed at all in terms of how the bookings actually flow into the month?

Jonathan Bush

Well I think Karl mentioned that our sales cycles have elongated because there is no sort of Uncle Sam with a rifle sitting on the lakeside going to blow you away, if you don't make a move. So that changes the mandate, you got to build a more organic cost base sort of long internally direct a strategic mandate in your prospect. That is a much more comfortable strategic place for us to be but it is a different place and we're having to build up that new sense of urgency and pipeline backlog. So that we've mentioned the elongation, that is elongation.

Yes, that is elongation, so that's the change in booking dynamic is there is no gun to anyone's head. This is got to be something that they want to do.

We're very confident that we've got a value set that will get them to want and that they will want, but it will take a slightly different product approach on our side and it will need to build up from a different set of prospects with a different set of needs before it flows at the same pace.

Karl Stubelis

Yes, but in terms of if your question is more rooted in we provide a bookings number that is net of any charge-backs or anything like that. So we're not seeing anything that is abnormal in that space, it's more or less in the group segment, we're seeing elongation right now.

Jonathan Bush

Right.

Karl Stubelis

And that the enterprise market remains certainly a healthy market and as we've talked about many times before it is a lumpier market.

Jonathan Bush

Yes, I mean this change in market fit is good for the world, with the market is going to on the provider side, I think it's a much healthier more broad-based resilient set of decision factors that I'm much more excited about building for. I think all of us at Athena most of us feel that way; it's just a shift, so we've got to press through that shift.

Operator

Thank you. And our next question comes from Robert Jones of Goldman Sachs. Your line is now open.

Robert Jones

Thanks for the question. And Karl you kind of just started to touch on just sticking with the bookings topic but wanted to ask on enterprise, it sounds like the shortfall is more in the small and group but on the enterprise side, how would you describe the booking results so far there relative to expectations, is demand for organizations wanting to switch where you thought it would be at this point?

Karl Stubelis

So, as we look at enterprise, it's largely the same that we have seen in the past, right. We've got a great product in the market that's resonating well, it's just -- it takes a while to get there. We have yields that are of enterprise size that we've talked about before as it relates to our emerging services specifically population health and the offering there as well. So I don't know if I characterize it any differently as if it's been sort of business is usual, it's a tough market that we're going through.

Jonathan Bush

I will show in one shift which I think is just in the whisper stages but will blossom here and that is a shift from buying sprees and desperate sort of desire to tame or manage to control doctors by health systems to clinically integrated networks spree. So this idea of meeting the federal definition of a clinically integrated network which allows you to collectively bargain price and the classic deal here is I will get you hospital system prices but you will still be in independent practice, this appeals to the majority of physicians that have not already sold and to allow the physicians that have sold their practices that are in places of tension with their enterprise health system sort of new employer.

That work is a two-stage sale, it's one that we do very well and because of the capital free implementation, the speed of implementation, the broad-based kind of front end that we can offer where people can get implemented without running through some giant program management office that you think of kind of a Deloitte well known [ph] for a Epic or Cerner implementation.

So we're the ideal partner, this is a focus if you want to do channel checks on around -- on the enterprise space, ask about their plans to build what they call CIN, Clinically Integrated Networks that's the space that is emerging, it is a kind of more of a hunting license it's much more significant than a hunting license but it's definitely a two-stage sale, you win the sale and then you go and you ask the doctors to join or you ask the doctors who have joined to get to a new level of alliance.

Our population health success has been very, very helpful in securing our role as a sort of, I think we will be the emerging as the preeminent Clinically Integrated Network partner even for big Epic and Cerner customers who know that they cannot roll those systems out to voluntary docs.

So that is an example of a fundamental demand shift. You saw our Tandigm announcement that's a little bit like it, that's a clinically integrated network deal, it's a very big deal by a very well DaVita is one of the partners there extremely good physician management player but we -- it's two sales, we had to win from DaVita and Tandigm and now we have to go out and win with the doctors in that network.

Operator

Thank you. And our next question comes from George Hill of Deutsche Bank. Your line is now open.

George Hill

Hi good morning guys and thanks for taking the questions. I guess Jonathan usually I'm not familiar, if you think about this industry longer-term especially in small and group space.

Jonathan Bush

George do you need headset, sorry buddy, you're little scrambled eggs there, one more time.

George Hill

Yes, if we think about the small and group space historically without the rate haul it's amongst the same thing happened, they haven't ever really wanted to buy anything and you're talking about the slowdown like is always the mix. I guess can you talk about what gets that market fully accelerated or what you think the timing is like to the reacceleration of that segment?

Jonathan Bush

Cash, cash is the thing that accelerates that segment and cash comes three ways, cost, rates, and new patient volumes. So our product focus is on those three things, we will talk more about what we're going to accomplish during 2017 on those three fronts. But these guides so rates come from joining clinically integrated network of some kind either sponsored by the hospital, we are one of the large number, I'm sure you are tracking George this decent size number of venture back or PE back at risk sort of primary care network companies that are going after the sort of disaffected newly employed hospital system docs with a different value prop.

That said those are the two ways of getting your rates up and the ways of getting patients volume up to get market share up is by being better at engaging with patients in their moment of need online. And obviously we're talking just in the ACE-IT space on that front and we're hoping to grow into a full fledged giant there as well. We will talk more about those. But those are the three things that move the needle, we are very confident that those are three things that we can dominate but we are building towards it.

Operator

Thank you. And our next question comes from Donald Hooker of KeyBanc. Your line is now open.

Donald Hooker

Great, good morning. So I would like to shift something to may be more positive. In the hospital space, I'm very interested in your ongoing development there and I just think it's worth kind of checking in there, kind of what the possible landscape is, I know you commented in your prepared remarks that you're getting pretty good progress there. Every deal is a replacement may be can you update us on the types of conversations you are having with hospitals and what's causing them to switch to athenahealth away from a legacy vendor. Thank you.

Karl Stubelis

Great question. Thank you. Sunshine on my shoulder. We have two big emerging services that are growing at a roaring pace on a small base. One is population health and the other is in-patient. In fact I just walked past, I did not have the energy, I was so tired coming back from Trinity last night, I could not join them at the restaurant but 10 fabulous health system CEOs, hospital CEOs here in town walking the halls of athenahealth and going through their plan to get to the cloud.

And that division is blossoming, it's exciting because these are people that desperately need it, they've had no oxygen for decades and suddenly there is a business model that actually pencils out, no CapEx, more cash in one year, lower cost. Like boom, just oxygen, so that thing is going incredibly well, obviously we have to be very careful not to oversell, not to take on more complex clients, we don't.

What happens in our world is if you get a bunch of really delicious big complex clients and you are a type A millennial, you accommodate those clients with software. You build features that you think they will use that they will use to get benefits. If you stay disciplined what you do is you build benefits that they can't help but get.

In the early days of athenaClinicals we built a lot of features that we did not build from the backbone on out. We built them at the safe level where the customer could configure them. And now we are having the streamline to reverse all of that work. We're being very disciplined to build athena in-patient athenaOne in-patient from the insight and the backbone out.

And same thing with population health. These are very large health systems used to getting their way, we want to get them their way, but the way we want them to get is the results not the features. So that's our focus is don't over blow it, don't go too far up market too quickly. We have a common formulary, we're going to have a common charge master up when the arguments. We're going to have very and win a lot of arguments here so I like to stay at work.

Where that backbone benefit, where you just, you don't have to set anything up, you just sign up to what it's already been setup. And it scales so fast and so well up market once it's locked. So it's going very well, we're going to grow that hell out of it, without going very far up market we'll talk more about those two businesses we'll focuses on those at the Investor Day, which you'll all attend on December --

Jonathan Bush

15.

Karl Stubelis

15.

Operator

Thank you. And our next question comes from Ross Muken of Evercore ISI. Your line is now open.

Ross Muken

Good morning guys. So may be just starting on the P&L quickly, so call the implied EBIT or operating income for the year given we have one quarter left, at that revenue level would suggest sort of a decent pickup sequentially. I'm guessing may be on the sales and marketing line. Can you just help us understand one the cadence of operating expenses obviously your incremental margins have gotten better this year and how you're just thinking about how that's progressing? Two, what's kind of implied in 4Q and where the pushes and pulls that could lead to a better or inline outcome may be on Op income?

Karl Stubelis

Yes. So we're pleased, we're very, very close to our internal budgets right now, which informs our guidance obviously. As we mentioned many times before we said it 12 -- 11, 12 months ago and we are -- we execute against that. I think what you'd see for -- I trying to get out of the business of fine tuning quarterly guidance, guiding within guidance right now.

Jonathan Bush

That's all we never got into that.

Karl Stubelis

Well, exactly.

Jonathan Bush

As we thought, what we thought.

Karl Stubelis

So rather than sort of give you the puts and takes of where it is for the quarter, we reiterated where our guidance was in beginning comments here. I'd rather just leave it like that; leave it at that for our guidance.

What I'll say is that the amount of our focus and instrumentation and unit level metrics that we go through and we are instrumenting in the business is increasing daily. So our understandings of exactly sort of deep down in our -- in the engine room, if you will, of what really is going to influence us, not just in the short-term, but in the long-term as -- is grown up measurably this year and I really look forward to that for next year. So I think that while bookings isn't where we are or where we want to be that is -- that it's just not an indicator of how the business is run on a daily basis obviously. We'll get new team here that is really embracing how to actually make this really perform.

Operator

Thank you. And our next question comes from Sean Wieland of Piper Jaffray. Your line is now open.

Sean Wieland

So I want to go back to the Tandigm deal, I thought that was interesting and just wanted to hear you describe that a little bit more. I think it's an IPA model, but can you tell me exactly what the model is there how significant is it -- that is backed by ACP and what kind of -- are there other similar opportunities is this representative of the make of what's happening in your pipeline?

Karl Stubelis

Well obviously there are no I mean ACP is a beautiful unicorn in so many ways that we love in worship. But many, many people are interested in that business model. There are many privately capitalize sort of poor profit ventures and most of the major health systems that we work with or even as prospects are very interested in building clinically integrated networks. It's an IPA what they -- it's any entity that meets the sort of federal, any such definition of a clinically integrated network I've seen in that accomplishes that, I've seen in that most or merged with Epic or Cerner accomplishes that in places where we've done that, and we are very interested in doing a lot more of those. Of course nobody performs like healthcare partners but I think that a lot of people are going to take on this value prop.

I think that the way it has reached the top of the beach in terms of acquiring doctors and making them put forth the logo of the local hospital, in fact in some markets we're seeing some defections and through some of these clinically integrated networks there are others that operate with various forms of business model. I'm sure you've been following the rise of Privia or Diligent these guys are ruling doctors away from health systems with a risk contract and a lean kind of doctor centric corporate structure and we expect to see a lot, lot more of that in the next couple of years.

Operator

Thank you. And our next question comes from Ricky Goldwasser of Morgan Stanley. Your line is now open.

Ricky Goldwasser

Yes thank you, good morning. So you talked about the fact that the market has changed right and the focus of the value proposition has changed seems that the docs or the practices are more inward looking focusing on metrics like operation side. So one how long will it take you to build the product is it the practice need and second are we heading into this interim period with some slowdown on the top-line but also higher R&D spend as you build this new product cycle?

Jonathan Bush

Great question. We will talk a lot more about that on the earnings day but you're right, this is as Karl said, as I said long before Karl said the helm, if we're not going to get that number and we are sure we will tell you and this is the first time we have ever been like yet not we're actually not going to get, there is no like one guy if he signs we may get it or beat it as usual at this time of the year, it's definitely not going to happen, it's definitely related to this fit, this shift in what the market is dealing with the big, the big kind of mallished great leap forward from the core that everyone self buy EMR is kind of exhausted itself, we're changing administrations. The new one will be we will start like exhausted for sure with very, very low probably the worst mandate of any administration in my natural life. So we are not expecting any more great leap forward type regulation and that means we shift.

Now it's not a new product, Ricky this is core to athena's origin right, we are a cloud based business service, we do work with our three ingredients, our network, knowledge and work, we got a rules team that prevents work from being formed, we got business engine that does work for client. What we plan to do and we will go into this more in the future what we have already done, I can certainly do it that way as an update on this year, 20% of the work on athenaCollector that goes into the client side whole bucket for the client to fit. That we originally defined as hey this is really better for you to fix so you don't make this mistake again kind of a self-discipline thing. We have now taken on, so 20% of the work that went into client whole buckets this year Athena has gone back in and taken out. We expect to do more and more of that driving down the number of staff that a doctor needs in order to be successful on our services. So it's not a new product, it's not a new platform; it's a deepening of the platform.

In terms of new platforms, I know you have all been following Prakash Khot and you should, it is a exciting, Hardy boys have nothing on the journey that he and the R&D team the adventure that they're on here. The opportunity to go back through the oldest cloud based service, Internet native app in healthcare and move it to a web services architecture and get enormous R&D synergy as well as operation synergies is really part of the excitement around here.

We're going to go into more of it but just as a taste, we have got 400 people doing separate threads of EDI. We've got 196,000 separate interfaces that have been built on chassis that were themselves developed in reaction to opportunities that connect. As I've told you in past calls, all of a sudden the dominant hospital IT players, enterprise software players have opened up their commons to interfaces, we have an enormous increase in the number of connections and the depth of those connections that we're going to be able to make.

We are building a new EDI platform; this is going to be night and day in terms of its reliability, its stability and in terms of the cost of adding new network connection. This is stuff that is not going to drive up the cost of R&D, it's going to drive down the cost of operations and you will see that, it's exciting now that this mandated, we had to choose capability over competence over these last seven years.

We needed to make sure during this sort of what is the right word this, sort of stampede federally mandated stampede towards whatever that work EMR means, we have to just make sure we laid along the capacity overpay for marketing, overpay for sales, don’t miss any of this because it's going to end and then you're going to the way it is going to receipt of the beach and you're going to have, what you have forever.

That pivot is exciting because we can go back to look at efficiency over capability and it's there is obviously there is great opportunity it should be. I have no apologies for going after during this buying spree every incremental buy inefficiently and I can't wait to finish out the work of now tuning up what we've got.

Karl Stubelis

It's more of a retune, Jon the way that I interpret is it is more of a retuning and a recommitment tool, so that the value proposition that this whole company was founded upon.

Jonathan Bush

That is right. We have been clubbed together with everyone else as the government has mandated us and now is the time for us to reassert ourselves in terms of the great value proposition and business model that is unparallel out there that we just need to separate ourselves from that.

Karl Stubelis

If you listen to Todd Parks original road show, he did his own parallel road show Merrill Lynch back in 2007 when we did our IPO and what do you think drives revenue, he gave almost verbatim the word I gave to the question and answer to the question, three questions ago. Cash, if you can generate cash in this starving nervous market reliably without cash up front, you will win lots of market share.

Cash used to come from the kind of the price, the present run at the HSS for the last six years, now it's going to come from the market, from the risk of doing the work and we know how to do that and we're going to double down on it.

Operator

Thank you. And our next question comes from Greg Bolan of Avondale Partners. Your line is now open.

Greg Bolan

Hi thanks guys. Just going back to the P&L, 17% revenue growth reported, is it correct to assume that core was probably closer to say 19% and then secondly I can't help but just going back to Ross's question, revenue growth in the fourth quarter implied be up I guess around 10% and I haven't had many cups of coffee this morning.

So hopefully I'm right but 10% sequentially up in the fourth quarter down about 16% in the quarter after the fourth quarter is what is implied, I guess going back to Jamie's question, I mean it does seem like hiring has picked up significantly over the past couple of quarters. As we think about the fourth quarter, is there still kind of I guess a backlog or pipeline of hiring expected in the fourth quarter or and or related to selling and marketing, is there something that you guys are kind of that you have up sleeves that you want to kind of get out done from a advertising perspective or just from a selling perspective that might be a little abnormally high in the December quarter and I will stop with that, thanks.

Karl Stubelis

So looking at the core Greg, the core is stronger and this core is up over 19% right now we're seeing for the quarter, so your inclination is right there. A reminder that we talk about last quarter that our first half and second half revenue was up always accelerated. So if you go back and look through history, you find that Q3 and Q4 are sequentially stronger than they are quarter-over-quarter.

I guess and going back to the Q4 thing, I remind you that where paper performance culture and company, so our year-to-date scorecard which everyone is compensated upon is about 80% right there. It's largely driven by and the misses that you can see out there in terms of where we are – turnover MPS and our booking things. So there is nothing anomalous going out there, Q3 was certainly impacted by lower bonus and commissions.

But I'm going to stay away from sort of guiding Q4, this is where we have discussed it is near the mid-point.

Jonathan Bush

I understand the desire to look at hiring and figure out, you could also look at the provider adds like we're not as the great men of multi-python like to say, I'm not dead. Actually feeling much better.

Operator

Thank you. And our next question comes from Eric Percher of Barclays. Your line is now open.

David Ho

Thanks. This is David Ho on for Eric. My question is related to the hospital EHR product, so could you guys provide an update on how your progress either building out or perhaps finding partners in the MD program for the kinds of ancillary modules that might be critical for the larger 200, 300 plus bed hospitals, how that has been going and then maybe another question. How many larger hospitals, the partners the size of university of Toledo are more today? Thanks.

Jonathan Bush

We have only the University of Toledo, I think we have room for two more large alpha we are very close with at least one that I know about, in terms of the feature set and the partner set, we are very comfortable with the partner set and the feature set for the market we are in. We don’t know what we don’t know as we expand. So as we implement Toledo we will figure out and we're doing some work with BI as you know development partner here in town that is much larger than Toledo on where incremental, sometimes it is not new packages or new apps, it is just a new reporting layer on top of the old workflow because now instead of 12 tasks in queue, you have got 650 tasks in queue and so the way to visualize that two is just different.

And sometimes it is just little stuff like that and then it is building a base of confidence on how the payers pay and how the rules work and things like that. But in terms of our work on inventory management on GL on well tax we have got some new partners but they are very new, so we don’t know how pressure testable they are vis-a-vis we did the surgery and the prescriptions ourselves.

So those are native to the app and very strong. So I think it is good, MDP More Disruption Please the marketplace where we build, it has been a longer road than I like, I mean this has started in 2011 but we just had all the CEOs of the More Disruption Please market or the 100 that we had room for up in our conference center in Maine and really, really, really cool, we got our original partners that have been there for years that have gotten lot of sales but we've also got these cool new apps including one there is a full electronic medical record that would sit on top of athenaClinicals. So the screens would be for a given subspecialty doctors could use a completely discrete apps on that even though all the orders results quality scores, docs and care would be filled by the core athenaClinicals service.

That is really exciting to me, that is the first time I have seen the real potential of MDP coming together, I saw another similar company at our first India MDP conference, we are opening a wonderful R&D hub in Bangalore across the street from the golf club right in the middle of the original sort of ally there and we had a little mini conference with the demo show and local BCs they are funding companies for the ACIT space and then it build some shift really. It was humbling and inspiring at the same time.

So we are expecting to see a lot more out of that space. Could you do make the point that working with the sort of original ACIT companies that were already out there that were really just using our marketplace as a place to get HL7 interfaces and channel partnership. I mean that is great and that helps, it helps our customers buy more products more quickly, more reliably but this app store concept is still in germination and some of the recent stuff is starting to it sort of what I would have like to see about 2013.

Operator

Thank you. And our next question comes from Sean Dodge of Jefferies. Your line is now open.

Sean Dodge

Yes good morning, thanks. Jonathan you guys have talked about leaning more heavily on athena owned channels for sales regeneration to take some pressure of your sales and marketing investments, is it still early days for this, have you began to see some traction here and how far are we away from seeing this generator or contribute margin levers?

Jonathan Bush

Not early days, it is happening. We will update you more on that in the investor day that work is going on, I think also our marvelous channel partners have not completely evaporated but dropped massively out of the mix as the mandate game dies down. It is a much more complicated conversation to talk about hey doc, I have got a program which could eliminate half the staff that I built all these wonderful relationships with all these years. That is a tough conversation, hey doc I have got a thing that will help you comply with this new federal mandate that is an easy conversation.

So we are working with our partners to refactor their pitch but don’t blame them for being slow in the pivot and the result is that most of the volume you're seeing a much larger share of the volume that we are seeing in our lead and leading pipeline comes from athena.

And we have had a lot of success with content in his script, Karl mentioned Zika programs, our content team has got a wonderful reservoir, the largest single integrated real time clinical database in the history of the world to work with and as it gets more and more instrumented as we build web services that force more and more consistency, we chase out the old pretty streamlined athenaClinicals data which is more easy to customize at the site level, that thing is going to spike. So you will see a shift in our marketing and sales efforts on kind of advertising and channel partners through to content and what we call network originated sales.

People that are already on Epocrates upgrading to population health, people that are already on population health upgrading to maybe just clinical, people who are on standalone clinical upgrading maybe the collector et cetera. That past that Rob Cosinuke laid out, three or four Investor Days ago is coming into focus in the mix that we are seeing or meeting mix already and you will see more of it in Investor Day.

Operator

Thank you. And our next question comes from Charles Rhyee of Cowen. Your line is now open.

Charles Rhyee

Thanks for taking the question, Jonathan you talked earlier about what are the three different things that will drive physicians ahead, one [indiscernible] talking grades and going into these kind of risk based physician groups, can you talk about the shift in value based care and why perhaps it is not moving faster than you would think that it could given you are seeing from CMS a great push in all these different programs right ACOs et cetera, PPCI. Why is that a bigger driver for physicians to make a move?

Jonathan Bush

Yes if you look at the real, it is interesting you say value based care, so if you look at the real dollars in play like you could lose as core revenue or up incremental economic rents that you could gain, there isn’t much of it in the United States today despite all the talk. Partly was that the original push into value based care by CMS, ObamaCare was extremely incremental this idea of an ACO that takes the first two percent itself and gives you half of the incremental savings, 18 months after you generate them when it is done calculating them, even if the calculation is wrong you still have to accept it.

And if you generate savings for three years, they reset your base at the new lower number, I mean it is a crap game to play, so not many people really play it, there is a few companies that are standalone, independent to the hospital systems that have more to gain, the economic rents doesn’t come out of their own, I mean the other problem is most of the ACOs are affiliated with us knows that the savings would come out of the hospital.

You're saying give me a bonus, you are going to give me a finger for cutting off my hand, thank you. And so it hasn’t really moved now, another word that is sometimes interchanged with value based care is population health, this is a concept which in many respects works in the fee for service world as well.

It positions you for value based care for real risk but it works in fee for service, so knowing who your patients are, who affiliates with you and your brand, have they had primary care screenings, do they have acquired diseases, are they getting their questions answered, this idea is creating a huge bone for our population health business, a wonderful way forward for our big enterprise clients that need to grow without anymore M&A, they can't do and that you will see a lot more M&A hospitals merging in doctors being acquired, if you are doing that now, you are really, you are playing with the level I think. But growing market share, growing agile kind of dynamic, comfortable online patient affiliation relationship.

That is something that works in a fee for service and risk world and this whole concept of clinically integrated networks is an example of that, it works on both sides of the risk and you will see a lot more of that coming up and that is working for us, that is where a lot of our we have got some areas they are not growing 30% we wanted and we have got a couple of areas that are growing 2 or 3 or 4X the 30% that we want and those are the areas where that is happening.

Operator

Thank you. And our final question comes from the line of Garen Sarafian with Citigroup. Your line is now open.

Garen Sarafian

Thanks for squeezing me in. Hey Jonathan, I appreciate all the color on the market shifting from federally mandated motivations to more of organic reasonings and analysis [indiscernible]. But from the sales perspective, I thought August was when sales gets together to reformulate their messaging to respond to market changes and what else, so how long does it take to change the messaging of an entire sales force and of course any changes thus far in sort of preliminaries also would be great as well. Thanks.

Jonathan Bush

Yes it is wonderful, so we have I think we started this conversation with you in Tim's presentation at the last Investor Day, I think there was...

Garen Sarafian

Two investor days ago.

Jonathan Bush

Two investor day, so this pivot is not new, I think what we're doing as we chase this pivot through sort of the food chain we are seeing more and more opportunities to pick up other areas of the pivot like the number of strokes of work that we thought we could take away from the customer, we now see many, many more strokes of work that we know how to take away that we didn’t use to know how to take away. For example over the course of our last trip to India, we identified millions and millions of tasks that we could take away from clients, if we just agree to do some certified coding, we had always said let's not go there, if not worth the risk we are already adding so much value, let us not take the witch hunt risk of CMS.

Now we are saying no, these codes are binary, they are absolutely logic driven, there is no judgment, there is no up coding potential here, we follow our course, our algorithms properly and we will eliminate thousands and thousands and thousands of tasks per customer per year. So those are examples of things that are coming up. But if you look at Tim O'Brien's last Investor Day commentary, we have already started a significant pivot from kind of crouching at the water, spending all our money on EMR and MU keyword sponsorships on Google to Webinars and research and how two guys we have started a three year project with Lazenger [Ph] my favorite professor ever, who created the service value chain at Harvard Business School and has run universities and great service brands, taking that whole framework and overlaying it on the economics of branding, growing and running a medical group.

And you can't believe the variation that we are finding in the opportunities for gains that we are finding, the first time he revealed any content was at our strategic client forum several months ago what was that July I think of this year. So this pivot is underway, you are absolutely right that these pivots take forever compared to what I would like to see but I'm very confident that we're already tracking in the sales force will come into line in the coming years.

Operator

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Mr. Jonathan Bush for closing remarks.

Jonathan Bush

So I think the big news of course is that I have been promising to tell you if I ever thought that there was no chance of making 30% booking growth, I never had to because there is always a chance, there is no chance. The reasons behind it are fundamental shift in the market, a shift that inspires us and that gives us more confidence in our ability to differentiate ourselves from traditional software, install it and run the traditional way.

These cost removing programs are not possible in the standalone enterprise software framework and so our ability to differentiate ourselves from the whole world will continue to source, I believe that our team including our new Chief People Officer is ideal for this, there is plenty of fresh eyes mixed in with our fabulous athena veteran and so I have never felt so inspired about the potential for the healthcare Internet to emerge and for us to be its benevolent dictator, I'm just kidding for us to be a relevant participant. Thank you guys very much; we are looking forward to seeing you on that Investor Day on December 15.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day everyone.

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